This in relation to industry analysis.
What is the difference between structural chages and cyclical changes?
I assume there are some changes which are exist in other industries. Am I right?
Please give some examples.
I interpret structural change as a change in a region’s predominant sector or type of economy. Examples: change from open economy to closed economy through tariffs; change from agricultural economy to industrial economy.
A cyclical change might mirror the classic business cycle’s stages (but doesn’t necessarily follow it as frequently or at the same time). Usually, the more CapEx, the more sensitive. Example might be the steel mill industry being affected by the commodities cycle (for iron).
Structural changes are permanent: textile jobs leave South Carolina for Indonesia.
Cyclical changes are temporary: the economy’s in a recession, so people buy fewer Ferraris; they’ll buy more Ferraris when the economy rebounds.
Thanks guys.
I have some follow up questions. Hope you can answer them.
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Does a temporary change only refer to the business cycle? If so, does that mean the time horizon used in industry analysis must be equal to one business cycle (either local or global)?
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As for a structural change’s relevance in the industry analysis, is it only to be able to differentiate the industry’s profitability which was a result of the business cycles and that of a structural changes? Is it correct for me to compare industry’s cycle of profitability from temporary changes to recurring profit and industry’s profitability from structural chnges to non- recurring profits?
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Assuming you are new to an industry, where would you look for the industry’s structural changes? What information sources would you use?
Q1) Like most qualitative concepts the word “only” is pretty strong. Generally yes, the business cycles of companies are comprised of temporary stages (hence the term cycle). The business cycle isn’t necessarily correlated to local or global, which was something I tried to get at earlier. Some companies are counter-cyclical to the macro (national or global) economy, but still follow their own business cycle (health insurance companies, for instance). The key with business cycles is you could look at a time series and see that they follow (to some varying degree) a pattern.
Q2) “An industry’s structure can be reshaped in two ways: by redividing profitability in favor of incumbents or by expanding the overall profit pool. Redividing the industry pie aims to increase the share of profits to industry competitors instead of to suppliers, buyers, substitutes, and keeping out potential entrants. Expanding the profit pool involves increasing the overall pool of economic value generated by the industry in which rivals, buyers, and suppliers can all share.”
Based on this logic I’d say there’s no reason why structural changes couldn’t result in recurrent profitability. Reading #31 gives an example of how Microsoft capitalized on structural change, and if you remember they almost lost an anti-trust case.
Q3) This is no easy task and I’d bargain looking at structural changes is probably one of the things that sets great equity investors (growth or value) apart from the herd. I’d imagine some of the key areas to look would be technological changes, educational trends, immigration patterns, regulations, and who the key players in an industry are (and are now not).
I appreciate your lengthy reply. Just have a few things below.
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I was just trying to clarify my understanding of a structural change’s relevance to industry analysis through my analogy. I actually just read the book and found what you said on number 2 the other day.
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I think you answered what to look for. Not my question of where to look for. I was referring to where you can find information on what you mentioned- technological changes, educational trends, etc… I am thinking I can find technological changes from industry specfic journals. If its not too much of a hassle, please share your thoughts on these.
Sure thing. My thoughts.
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Good deal. I think finding “value” in companies has a lot to do with anticipating structural changes (especially growth investing, i.e., Lynch) and predicting cyclical changes properly (i.e, Neff). If that’s even really possible (i.e., Bogle). But there’s a lot of crossover here and all these changes somewhat bleed into each other.
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Well, think about the question itself. Where to look is the million-dollar question. There’s no “answer.” Mosaic theory and big data aside, trade shows, business conventions, academic experts, and scientific journals are probably good places to start. A tangentially related concept, in my opinion, is how a lot of economic models get criticized for not being able to “fully” incorporate technological/progress, which I’d largely associate with technology. Check out the “Solow residual.”
You got me more interested on structural changes when you mentioned Lynch and the rest. I don’t know if solow residual is part of the CFA curriculum so I will just have to put in on my to read later list. Once again thank you for your thoughts and the information sources.
Definitely a waste of time now, but it’s more or less the idea of why you have an obscure concept called “TFP” in your Cobb-Douglas function under the Neoclassical growth model. The math (which S2kM can explain better) works, but the concept is relatively lacking. That’s usually why it gets ragged on.
I think you are in the wrong post
You asked how to seek out catalysts of structural change. I was trying to tie these concepts together to illustrate my belief, which is that, whether it’s called a structural change under Porter, or TFP under Neoclassical, it’s usually mostly (if not completely) a technological catalyst, but those things are hard to measure or describe, let alone anticipate (as you asked). Looking at workforce participation or quit rates and checking capital account balances (cyclical drivers) are infinitely easier than predicting the next Internet.
Think most plantation owners in 1800 predicted Amendment XIII? Unlikely. Think Microsoft predicted the iPod’s success? Nah. Graduating from high school is a relatively recent phenomena, let alone online graduate school. Don’t want to write a book, but… The relationship between industry/economic structure and industry growth (and thus risk) is woven tightly. You see more AUM in tech hedge/mutual funds than utilities funds.